Planning a Budget and Getting Out of Debt

Q: How do you do a proper budget, and what is the "Snowball Method" to get out of debt?

A: When in rough times (or just to re-evaluate what you're doing with your money), the first thing to do is re-learn the budget. Don't worry about your credit; you won't be using it. It'll straighten itself out in the process. Do not go to a debt management service. They can no longer get your rates down significantly. Also know that interest rates are not your enemy; budgeting and spending habits are. If you're blaming rates for your situation, you will not get out of it.

List every dollar you spend during the month. It's very easy to subscribe to this and that service or feature. You can $20-a-month yourself to death these days without even knowing it. You can save money by giving something up, such as a DVD rental program, cell phone, cable/cable package, long distance on your home phone, other phone options.

You might cash out a universal/whole life insurance policy to go to a term policy for more coverage and less money per month. Does your W4 at work have the correct number of deductions? If you get a refund at the end of the year, you probably need to adjust it. It's easier to keep your money by a well completed W4 than to get that money back from the IRS at the end of the year.

For student loans, if you must, you can get forbearance due to temporary financial difficulties. They have to let you do it. That might give you a leg up in the meantime, but know that the interest will continue to accrue. When you start up again, the payment will be adjusted. It isn't ideal, but it might be worth doing that for a year or 6 months to get back on your feet.

Do what you can to build an emergency fund. You won't have any credit cards catching your slack, so you need $1000 or so put away for emergencies, not just for spending. Budget by priority. It's just a good way to not miss anything as well as knowing that the priority items are taken care of. The lights will stay on, there's a roof over your head, and food on the table. List everything you spend. Leave nothing out, or you won't have money for it. Assign it to a level number, and put them in order.

Priority Levels

Level 1: Shelter - mortgage/rent, daycare

Level 2: Food, water - budget your groceries by week and know how many weeks there are in this month.

Level 3: Utilities. Electricity, natural gas, gasoline, basic phone service (drop long distance if you possibly can), strip down cable if you can.

Level 4: Insurance. Don't hurt your family/spouse if you die. Convert whole/universal life policies to term for a fraction of the cost. Re-evaluate your medical and auto for room for savings. Shop around.

Level 5: Cash. You have to keep some to fill in the gaps. We used $40 each a month. This was for anything that came up, or snacks on the road, lunch, paying the school for things that came up for our son, etc. No money for fun - this is a small catchall for those things that just seem to come up.

Level 6: Credit. List your debts in order of balance, not importance to you, and not by rate. Pay minimum on everything, and snowball your payments starting at the smallest debt and moving up (see below). Until these are all paid off (other than the mortgage), you are always sending out the same amount of money each month. More and more gets applied to the next bill as one gets paid off. Even if you get to jump-start this by selling that car, keep up with it. No cheating.

Pay things in order of level, from 1 to 6. It's a lot harder than it sounds, but it works and you'll always have a place to stay, heat, power and food. Live by priority. When you get down to Level 6, Credit, use the Snowball Method.

The Snowball Method

You're not just paying the minimum on everything, but you are paying the minimum on everything but the smallest debt. Plan your budget to pay an extra $50 or whatever you can do every month on the smallest debt. Always the same extra amount, no up and down, just because the minimum payment went down since you made some headway. No paying extra 1 month to get "yardage" to pay less next month. Again, you put these in order of balance, not rate.

At first you pay the minimum on all, but the $50 extra on the smallest. Then, when that smallest card is paid off, add that $25 + $50 you put in addition to the $30 on the next debt up the list for a total of $105 per month on the next debt one. When that's paid off, you add that $30 + $25 +$50 to the minimum payment on the next debt.

Until you're debt free, you always pay out $810 per month until you get to that top debt, which is getting the full $810 per month by that time. You see progress because the debts are falling off fast, which is probably the most important thing. Without that, you'd never finish. Interest rates are not the problem. The spending habit and borrowing habits are the problem. Getting out of debt is 70% psychological and only 30% financial. You need the fast goals of paying off from the bottom up, so that there's not only a light at the end of the tunnel, but also marker lights reminding you that you're on the way out.

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